What is the Earnings Per Share Formula?
Earnings per share (EPS) is a measure of a company’s profit per outstanding share of its common stock. It’s a direct indicator of company profitability. Investors are more likely to invest in a company with higher earnings per share.
What is the EPS formula?
The formula for earnings per share is:
For example, BlueJay Skyscrapers Inc. has a net income of $840M. It pays out $2M in dividends and averages 100M outstanding shares.
To calculate earnings per share, subtract the net income ($840M) by the dividend payout ($2M) to get $838M. Take $838M and divide it by BlueJay’s weighted average shares of 100M to get an earnings per share of $8.38.
What is diluted earnings per share?
Unlike standard earnings per share, diluted EPS assumes the exercise of all convertible securities. This includes stock options, convertible debentures, warrants, and convertible preferred shares. This is a worst-case scenario measurement, and diluted EPS is almost always lower than standard EPS. The formula for diluted EPS is:
If BlueJay Skyscrapers Inc. has 5M shares of dilutive securities, add it to the 100M outstanding shares to equal 105M. Take the original numerator of $838M and divide it by the new denominator of 105M to get a diluted EPS of $7.98.
What else is earnings per share used for?
What are some drawbacks of using earnings per share?
An investor can’t tell what a company’s share price is by only looking at earnings per share. They need more information if trying to determine if the stock is undervalued or overvalued.
Another potential downside of using earnings per share is EPS tampering. A company can make its EPS look better than it is. It can decrease the number of outstanding shares, buy back stock, and inflate the earnings per share with the same level of earnings.
What is adjusted earnings per share?
There are certain scenarios that might cause an investor to adjust the EPS formula. If there is a one-off event that drastically affects net income, an investor may want to remove this from the calculation. These adjustments are made to the numerator of the equation.
Earnings per share shows us the amount of profit a company makes per share. It’s calculated by subtracting preferred dividends from net income and dividing by the weighted average of outstanding shares.
It’s an important variable for calculating P/E ratio, but it has its limitations. Earnings per share can be manipulated by companies, and it does not show an investor the stock’s price.
Earnings per share has different variations depending on the situation. Diluted EPS accounts for convertible securities, and adjusted EPS accounts for outlier variables.